Is capitalism finished or has it just caught a nasty cold? This series of articles will argue the case for a different style of capitalism.

Friday, 4 December 2009

Turning Forwards – Getting Back to Common Sense

Where does Capitalism stop being Common Sense?

In our last post “I’m Walking Backwards to Christmas …” we talked about wealth creation. And, being a bit ambitious, we offered a definition of real wealth . There was too much else to address in that post but we think we left some assumptions hanging. And we think that these assumptions are central to our Capitalism or Common Sense theme.

First and foremost, we assert that there is a fundamental difference between the creationof wealth and the acquisitionof wealth.

§The creation of wealth means that the sum total of real wealth is increased regardless of anything to do with possession.

§The acquisition of wealth means that the sum total of real wealth is not increased, merely shifted from one possessor to another.

This reflects the Laws of Thermodynamics, the first of which states that a simple Perpetual Motion Machine is scientifically impossible. In other words, you cannot have Output without having Input – and that isn’t just science, it’s Common Sense. This principle is not limited to just physicists’ Energy; we can take the view that wealth is, in fact, the sum total of the economic energy within our eco-sphere. Extending the metaphor, wealth is what drives our economic world just as a battery can drive an electric circuit, and where scientists measure potential energy in Volts, the economic world uses units of exchange - currencies - money.

And this tells us quite simply that "money" is not wealth, it is just the numbers on the ruler.

Isn’t this all a bit obvious? We wish that we could believe that it was. We feel like the little boy watching the Emperor preening in his new clothes – are we alone in seeing the nakedness?

We argue that for decades a lack of intellectual rigour in financial, business, economic and political thinking has failed to distinguish between the acquisition of and the creation of wealth. We believe that this is a major contributor to the confusion, chaos, disasters and distress that are the outcomes of the Credit Crunch. It has all happened because so many of the people that matter, not least our Prime Minister and Chancellor, do not appear to have the slightest clue about real wealth – they really seem to think that it is money. Possibly this is because politicians’ only interest is spending other peoples’ money (they do not even bother to acquire it first, they merely borrow it regardless). The absence of adequate challenge to their impoverished and sloppy thinking is an indictment of the world of Finance, and all its acolytes, who have lost the ability to distinguish between the acquisition and the creation of real wealth. We wonder if the Opposition parties have too, we have heard little profound insight from any of them.

The sad reality is that a very high proportion of those that seek to become wealthy, or want to control wealth, understand only the acquisition of wealth – because they think that wealth is money. They have no idea where real wealth comes from, but they can be infinitely creative when it comes to grasping hold of someone else’s money. Many acquire large amounts of money to gain the power and influence that they are driven to pursue (no, it is not “a want”, it is more desperate and more dangerous than that) and they think that the result is “wealth”. And idiots fail to ask “Where does it all come from?”

If money isn’t wealth nor wealth, money – what is it?

We repeat, from Walking Backwards, our definition of real wealth issolid sustainable human, intellectual, technological,physical, market, and financial assets and resources that deliver benefitto the future of the whole community.

This single sentence contains a big load of ideas and to try to discuss them all here would need a book, and not a blog post, so let’s just highlight a few

solid sustainable = long lasting and robust

benefit for the future = not just today but tomorrow and next year

whole community = what it says on the tin – everybody, not just a few

The easiest way to illustrate the difference between wealth creation and wealth acquisition and its connection with our theme of Capitalism or Common Sense, is with this parable about a farming community –

The corn merchant sells seeds to the farmer who sows it in his land and tends the fields then pays the villagers to help harvest the crop. The farmer sells the grain to the corn merchant who sells portions from his granary to the miller who, in turn, sells flour to the baker who makes and sells the bread for the whole community to eat. The corn merchant sells the surplus grain to other customers outside the community.

If there are Good Harvests, then extra grain can be traded outside the community and the corn merchant obtains extra resources that he can choose how to use.

The effect on real wealth all depends on what the corn merchant really wants to achieve – let’s look at two alternative examples –

Edwardwho is determined to create wealth

Fredwho is determined to acquire wealth

Edwardcould choose to use these extra resources to help the farmer to obtain more land and manure to grow a bigger and better crop, so he could build more cottages to house more villagers, generating more income for the miller, the baker and the villagers. The miller might mill more varieties of flour so that the baker could offer a choice of different loaves. Edwardcould then build the bigger granary they all would need. He might also be able to create new benefits for the community such as a school and a doctor. The community’s real wealth, the totality of tangible and intangible assets, would have increased. Everybody would enjoy increased personal choice. And, if all the villages in all the land had an Edward, the real wealth of the whole Nation would increase.

Fredcould choose to use these extra resources to acquire assets in other communities – perhaps to buy out corn merchants in other villages - this would increase his acquired wealth. The overall wealth, the community’s totality of tangible and intangible assets, would not increase. If, in a short term rush to maximise the number of other corn merchants he can buy, he were to sell all the grain from his granary, the community’s totality of tangible assets, its real wealth, would have decreased. He might claim that stocks in his other granaries provide greater wealth for all. However, the majority in the village would have no gains in personal choice. And, in this case, if all the villages in all the land had a Fred, at best the real wealth of the whole Nation would remain unchanged, i.e. not increased.

As soon as there are one or more Bad Harvests, there will be a marked difference -

Edwardwould find that there was no surplus grain to trade and therefore no way to support the community’s next expansion. However, his good husbandry of granary stock would ensure that the farmer’s next sowing could proceed and the community did not starve. Its real wealthwould not decrease in hard times. People would continue to have personal choice but would see that it was limited. If all the villages in all the land had an Edward, the Nation would remain steady on its feet, its real wealthundiminished.

Fred, who had not husbanded his stocks, would find that was not enough grain in his granaries for either the farmer’s next sowing or the community’s bread, and certainly none to sell elsewhere. The community would suffer real hardship, the farmer would have much less crop (if any), the miller might go out of business, and the baker and the villagers starve or migrate. Its real wealth would decreasein hard times. The people would find that they have no choice left, only survival. If all the villages in all the land had a Fred, the real wealthof the Nation would be reduced.

However, it can then get much worse.

Fred’scousin, Shredder Fred, takes over and decides to “maximise quarterly returns” by selling all the remaining grain from all Fred’smultiple businesses. Then many communities would be left to die. Shredder Fred may then use his "acquired wealth” to buy up the now devalued assets of all the bankrupt farmers, millers, bakers and the cottages, in all the villages. He might then install overseers to drive the smallest possible number of villagers to work for the least possible amount of bread in order to create surpluses to enable him to acquire other assets. There will be no personal choices beyond survival left in these communities. There will be widespread human casualties and waste of resources.

And, if every village had a Shredder Fred, then after they had exhausted their resources trying to buy out each other, there would be little else left except a much smaller number of Shredder Freds, each using his own acquired wealth to try to obtain influence and power over the Nation. The real wealthof the Nation would be decimated.

So where does Capitalism stop being Common Sense and become Nonsense?

Here are our questions for you –

1) Looking at the quality of life for the Nation as a whole and for each community -

Who do you think

a) Improves it? b) Makes no difference? c) Ruins it?

2) Thinking about the "socially useless" argument about some banking activities –

Who do you think is

a) Socially useful? b) Socially useless? c) Socially destructive?

3) Looking at the real wealth of the Nation as a whole and for each community -

Which type of Capitalist,Edward, Fred orShredder Fred, do you think is

a) Productive? b) Unproductive? c) Destructive?

Which choices are more likely to lead to long term prosperity, stability, security and a good quality of life for the most people in the Nation?

Final question -

Do you think that this parable supports our assertion that the lack of intellectual rigour in financial, business, economic and political thinking that has failed to distinguish for decades between the acquisition of and the creation of wealth is a major contributor to the confusion, chaos, disasters and distress that are the outcomes of the Credit Crunch?

Do you think that, very possibly, this may be one of the causes of the whole disaster?

Our Comparative Competitive Strength point of view is based on the robust research that has proved that businesses that achieve true Excellencegenerate real wealthand withstand setbacks better than others.

This is not just “an interesting fact”. It is important. If we are to truly prosper again as a Nation, then we need to outperform all others. And to do that we need all of our communities to fully understand and apply the lessons and insights of the Comparative Competitive Strength point of view and to become genuine creators of wealth. We need Capitalism with Common Sense.

How might we reconcile Capitalism with Common Sense?

We can start with wealth acquisition. This is where Common Sense is most commonly disregarded, because the focus is too often on short term and self, both of which prove not to be Common Sense in the longer term. We asked in August if the prohibition of any trading in assets which are not actually directly owned could remove unwanted speculation? Could market damping (also suggested in our August blog) by means of share transaction delays and/or voting rights time embargoes (as Sir Peter Cadbury has just now proposed), and/or transaction taxes (proposed by Sir Stelios Haji-Ioannou),make a significant difference? Can we change the quarterly performance obsession of so much of the financial and investment world that inevitably drives out Common Sense from management decisions under this pressure?

Do we need to reward wealth creation by more generously enabling added personal wealth for those that take the risks and effectively manage them to create wealth? Should we actively reward good husbandry and punish reckless exploitation? What might happen if we had a tax and financial regulation regime that favoured the Edwards, disadvantaged the Freds and actively proscribed and prosecuted the Shredder Freds?

Could the government/regulatory role in a free market change to rebalance the current implicit bias that favours short term wealth acquisitionby introducing incentives towards long term wealth creation in the economy, with corresponding rewards for the effective long term risk takers who create wealth? The implications for fiscal and economic management are at least thought provoking. The storm of outrage from the Shredder Freds, the Freds, and all their many agents, would be deafening, even through they are such a tiny minority. As Winston Churchill never said, “Never have so many owed so much to so few with so little good reason”. A true test of our political classes would be the extent to which they could demonstrate through action that they are not “owned” by these manipulators of money and brokers of power.

If you were to be brutally honest with yourself – do you think you are an Edward or a Fred?

§Have you been seeking to create wealthby adding to the nation and the community’s assets and resources?

§Have you been seeking to acquire wealth by securing a greater share, either for yourself or others, from the community’s assets and resources?

R W Emerson said that we should be very careful about what we wish for because, more than likely, we are going to get it.

We state again that our Comparative Competitive Strength point of view is based on the robust research that has proved that businesses that achieve true Excellence generate real wealth and withstand setbacks better than others. If you would like to know more about these ideas please look here or contact us here.